Why govt should cut diesel subsidy in big cities, now

The Indian government is driving the country on the road to fiscal perdition. It missed its target of fiscal deficit by a mile in the last budget. It has transparently under-provided for fuel subsidies in the budget for 2012-13, suggesting that it plans to reduce those subsidies with active measures. However, in its desire to cling to power, its pusillanimity in political confrontation with its allies, and its fear that the opposition will oppose what it would itself do if it were in power, it is frozen into inaction in increasing diesel prices.

In 2008-09, the Petroleum Planning and Analysis Cell of the Union petroleum ministry had estimated the total diesel consumption in the country at 51.7 million metric tonnes. In 2011-12, the Society of Indian Automotive Manufacturers and the Working Group on Petroleum estimated the consumption at 63 million tonnes, an increase of 22%. Currently, the under-recoveries on diesel are about  Rs14/litre. This means that the annual diesel subsidy is likely to be of the order of about Rs 106,000 crore, assuming no further depreciation of the rupee, nor any increase in oil prices.

Since the diesel subsidy is causing fiscal strain and the finance minister seems to want to find a way of reducing it, the government should immediately act on a practical and quick-to-implement tactical measure, which would be more politically palatable.

After Parliament adjourns on May 24, it should direct the oil marketing companies to eliminate all subsidy on diesel sold in the largest Indian cities, only 50 of which have a population greater than one million. Oil marketing companies have full data of which dealers are within municipal limits and which are outside, making the suggestion easy to implement.

Simultaneously, the government needs to explain through the media certain facts to reduce the decibel of criticism that is inevitable.

Diesel is used for diverse purposes —  trucks (37%); passenger cars (15%); buses (12%), agriculture (12%), industry (10%), power generation (8%) and rail (6%). The government should emphasise that this measure will not affect the 70% of the population that lives in rural communities and depends on diesel for their pump sets, tilling and transportation.

Urban India accounts for 62% (2010) of the GDP but has only 30% of the population, thus limiting the number of people affected by elimination of the subsidy. Political parties will acknowledge that the less-privileged in many urban areas are served by electric suburban railways or public transport run on CNG and will therefore feel a relatively low impact of the removal of diesel subsidy, that the rich can afford an increase in diesel prices, and that diesel car sales are seeing a growth of 40%, much higher than that of petrol cars, because of the subsidy. Will any opponent of the government support subsidies for Mercedes cars?

There will inevitably be attempts to bring subsidised diesel from the periphery of urban areas for sale in cities; oil marketing companies will have to be asked to enjoin their dealers to refrain from colluding in such behaviour at risk of painful penalties. On the margin, there may be some non-urban dealers in the peripheral areas that may see some surge in sales to urban diesel vehicle owners, but that would not be significant.

In addition to the tactical elimination of subsidy for diesel sales in urban areas, the government should announce a structural move — the complete pass-through of oil price increases beyond $115 per barrel. This would have no immediate effect on the fiscal situation, given that the current oil basket costs India less than that amount; however, it will send a signal to the country for future price increases, though the risk exists that a weak government will not implement the measure when oil prices do cross that amount.

Removing the subsidy on diesel for sales in the 50 biggest cities will be politically more palatable than total removal of subsidy on diesel, will not affect rural residents in any significant way, will show that the government is not suffering from ‘policy paralysis’ as it is being accused of, will save several thousands of crores in diesel subsidy and change the country’s direction towards the road to fiscal rectitude.

The author runs IndAsia, a corporate finance and investment advisor, and was the founder managing director of CRISIL, India’s first credit rating agency